CME Group Market Regulation
Update on Revisions to Rule 538 and
Associated Regulatory Guidance
October 13, 2016
© 2016 CME Group. All rights reserved.
Agenda
1
Introduction
2
What is an EFRP?
3
Description of Recent Changes and Review of Unchanged Requirements
4
Q &A
© 2016 CME Group. All rights reserved.
Disclaimer
Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of
a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders
should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one
trade because they cannot expect to profit on every trade. All references to options refer to options on futures.
Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the
meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s
value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use
funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because
they cannot expect to profit on every trade.
Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.
CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago
Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New
York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity
Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other
trademarks are the property of their respective owners.
The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for
any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should
not be considered investment advice or the results of actual market experience.
All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be
consulted in all cases concerning contract specifications.
Copyright © 2016 CME Group. All rights reserved.
© 2016 CME Group. All rights reserved.
Introduction of Presenters
Thomas LaSala, Managing Director & Chief Regulatory Officer
[email protected]; 212.299.2987
Robert Sniegowski, Executive Director, Rules & Regulatory Outreach
[email protected]; 312.341.5991
Ryne Toscano, Director, Market Surveillance
[email protected]; 212.299.2879
© 2016 CME Group. All rights reserved.
4
What is an EFRP
General Information
• An Exchange for Related Position (“EFRP”) transaction involves a privately negotiated
off-exchange execution of an Exchange futures or options contract and, on the opposite
side of the market, the simultaneous execution of an equivalent quantity of the cash
product, by-product, related product, or OTC derivative instrument corresponding to the
asset underlying the Exchange contract.
• The CME Group Exchanges permit three different types of EFRPs:
• Exchange of Futures for Physical (“EFP”) – the simultaneous execution of an Exchange
futures contract and a corresponding physical transaction or a forward contract on a
physical transaction.
• Exchange of Futures for Risk (“EFR”) – the simultaneous execution of an Exchange
futures contract and a corresponding OTC swap or other OTC derivative transaction.
• Exchange of Option for Option (“EOO”) – the simultaneous execution of an Exchange
option contract and a corresponding transaction in an OTC option.
© 2016 CME Group. All rights reserved.
5
What is an EFRP
General Information
• EFRPs are governed by Rule 538, located in Chapter 5 of each Exchanges’ Rulebook,
and by the Market Regulation Advisory Notice on EFRPs
• All futures and options on futures are eligible for execution as an EFRP transaction
• Unlike block trades, there are no minimum quantity thresholds applicable to EFRPs
• The price of the Exchange futures or options component of EFRPs are not price reported
to the marketplace
• The Exchange component of the EFRP must be submitted to clearing as soon as
possible following agreement on the relevant terms by the parties to the transaction
• EFRPs may be transacted at commercially reasonable prices mutually agreed upon by
the parties to the transaction. The price of the Exchange component must conform to
the applicable futures price increment or option premium increment for the particular
product.
• EFRPs may not be priced to facilitate the transfer of funds between parties for any
purpose other than as the consequence of legitimate commercial activity.
© 2016 CME Group. All rights reserved.
6
What is an EFRP
General Information
• One party to the EFRP must be the buyer of the Exchange contract and the seller of (or
the holder of the short market exposure associated with) the related position; the other
party to the EFRP must be the seller of the Exchange contract and the buyer of (or the
holder of the long market exposure associated with) the related position. The Exchange
contract and the corresponding related position must be executed for accounts with the
same beneficial ownership.
• The related position component of the EFRP must involve the product underlying the
Exchange contract or a by-product, related product or OTC derivative instrument that is
reasonably correlated to the corresponding Exchange instrument.
• The quantity of the related position component of the EFRP must be approximately
equivalent to the quantity of the Exchange component of the EFRP. Appropriate hedge
ratios between the Exchange and related position components of the EFRP may be used
to establish equivalency.
Example #1: Invoice Swap Spread
Buy Dec 2016
TY Futures
Pay Fixed Swap 1
Start: 12/30/2016
Maturity: 8/15/2023
Example #2: FX OTC Cash/Futures Basis
Buy Dec 2016
Futures
Sell EUR/USD
Spot
Treasury Futures privately negotiated off exchange
as a package involving a specific matching interest
rate swap in the opposing direction.
As of Oct 4, it is also possible to trade packages of
multiple invoice spreads as EFRs, including tenor
switches and calendar rolls
© 2016 CME Group. All rights reserved.
7
What is an EFRP
General Information
The opposing accounts involved in the execution of an EFRP must be:
independently controlled accounts with different beneficial ownership; or
independently controlled accounts of separate legal entities with common beneficial
ownership; or
independently controlled accounts of the same legal entity provided that the account
controllers operate in separate business units.
Accounts with the same beneficial ownership include accounts owned by the same person
or entity, accounts of a parent and its wholly owned subsidiaries, and accounts of
subsidiaries that are wholly owned by the same parent. Common beneficial ownership is
more inclusive and includes not only accounts with the same beneficial ownership, but also
accounts with common beneficial ownership that is less than 100%.
Parties to an EFRP transaction involving the same legal entity or common beneficial owner
must be able to demonstrate the independent control of decision making for the respective
accounts and that the EFRP had economic substance for each party to the transaction.
© 2016 CME Group. All rights reserved.
8
Recent Changes
• Revisions to Rule 538 and the regulatory guidance contained in the MRAN were selfcertified with the CFTC on September 19 and are effective as of October 4
• The revisions include:
- Allowing an EFRP to contain multiple Exchange components with different market biases provided
it is not a transitory EFRP
- Allowing any eligible third party to facilitate as principal the related position component of an EFRP
- Modifying the requirements for CTAs and other account controllers executing immediately
offsetting foreign currency EFPs (“IOFXEFPs”)
- Modifying submission time requirements to CME Clearing for the Exchange component of the
EFRP
- Clarifying the responsibility of firms executing or clearing EFRPs on behalf of customers
- Eliminating the use of summary fines for failure to provide requested records concerning EFRPs to
Market Regulation in a complete and timely manner
© 2016 CME Group. All rights reserved.
9
Recent Changes
EFRPs with Multiple Exchange Components
• Effective on October 4, EFRPs may contain multiple Exchange components provided
that the EFRP is not transitory. A transitory EFRP is one where the related positions
offset without the incurrence of market risk that is material in the context of the related
position transactions
• This replaces an historical prohibition that EFRPs could incorporate multiple Exchange
components only if they had the same market bias, or different biases if the Exchange
components are legs of a recognized inter-commodity spread involving a physical
commodity product and it’s by-products (e.g., crack spreads and crush spreads)
• A few examples of transactions that became permissible include:
Invoice Swap Spread
Tenor Switch
Cash/Futures Basis
Position Roll
Buy Dec 2016
10Y Futures
Sell Dec 2016
Bond Futures
Buy Dec 2016
10Y Futures
Pay Fixed
Swap 1
Start: 12/30/2016
Maturity: 8/15/2023
Rec Fixed
Swap 1
Start: 12/30/2016
Maturity: 2/15/2036
Sell
Cash UST Note 1
T 2.5% 8/15/2023
Sell
SellMar
Mar2017
2017
TY
10YFutures
Futures
Buy
Cash UST Note 2
1.375% 9/30/2023
© 2016 CME Group. All rights reserved.
10
Recent Changes
Third-Party Facilitation of the Related Position Component of EFRPs
• Under the revised Rule, any third-party will be able to facilitate the related position
component of an EFRP on behalf of a customer.
• Except for IOFXEFPs, the third-party must be able to demonstrate that the related
position was passed through to the customer who received the Exchange futures or
options contract as part of the EFRP.
© 2016 CME Group. All rights reserved.
11
Recent Changes
Immediately Offsetting FX EFPs (IOFXEFPs)
• For IOFEXPs, CTAs and other investment advisors with discretionary trading authority
over client accounts do not need to demonstrate the booking of the two offsetting cash
legs to underlying client accounts.
• However, in the event that the futures leg of the IOFXEFP fails to clear, the buy (sell) of
the futures and the sell (buy) of the cash are void ab initio
• In that event:
- The offsetting cash leg (the cash leg with the same directional bias as the futures leg) must
continue to exist
- Previously, CME required the CTA or investment advisor to pass the offsetting cash leg to the
client account, requiring that such clients have open cash accounts
- Under the revisions, we permit the CTA or investment advisor to liquidate the cash leg and pass
the resulting profit or loss, if any, to the underlying clients
© 2016 CME Group. All rights reserved.
12
Recent Changes
Submission Time Requirements
• As of October 4, the Exchanges will require that the Exchange leg(s) of the EFRP be
submitted to CME Clearing as soon as possible following agreement to the relevant
terms by the parties to the transaction. Absent extenuating circumstances, the EFRP
should be submitted on the same day that the relevant terms have been determined.
• This replaces the more prescriptive one-hour requirement for EFRPs executed between
6:00 a.m. and 6:00 p.m. Central Time (for CME and CBOT products) or between 7:00
a.m. and 5:45 p.m. Eastern Time (for NYMEX and COMEX products)
• Market Regulation considers the relevant terms to have been determined at the time the
price and quantity of the Exchange contract and the corresponding related position
component of the transaction are agreed upon by the parties to the EFRP
• The Exchanges have maintained the exception which permits parties to contractually
agree to submit the transaction to CME Clearing once the actual delivery quantity has
been precisely determined. Absent such an agreement, the transaction must be
submitted to CME Clearing at the time of pricing
© 2016 CME Group. All rights reserved.
13
Recent Changes
Firm Responsibilities
• Under the revised MRAN, firms that execute or clear EFRPs on behalf of customers
should exercise due diligence in identifying circumstances in which a customer’s EFRP
transactions may be non-bon fide
• Firms that execute or clear EFRPs on behalf of customers are responsible for ensuring
that their customers are fully informed regarding Exchange EFRP requirements
• Firms are strongly urged to forward the MRAN to their clients
• Firms should have their clients contact Market Surveillance or Regulatory Outreach in
the event they have any questions the firm is unable to answer
• Firms remain responsible for obtaining and providing records of client EFRP transactions
in a timely manner when requested by Market Regulation
• Clearing members must take appropriate action if they have notice or knowledge of the
execution of non-bona fide EFRPs by their customers
• Account statements must uniquely identify EFRPs – it is not permissible to simply use
“ex-pit” or “ClearPort trade” as those terms may denote more than just an EFRP
• Firms may submit EFRPs to CME Clearing via CME Direct/CME ClearPort or via FrontEnd Clearing (FEC)
© 2016 CME Group. All rights reserved.
14
Recent Changes
Failure to Provide Market Regulation with Requested Records for EFRPs
• The Exchanges are eliminating the use of summary fines under Rule 512 for a firm’s
failure to provide requested records to Market Regulation in a complete and timely
manner
• Compliance is critically important to Market Regulation’s review of selected EFRP
transactions
• A failure to respond in a complete and timely manner may result in a recommendation to
the Probable Cause Committee that the firm be charged with a violation of Rule 432.L.
• If a charge is issued, the matter will be heard before the Business Conduct Committee
• If the Business Conduct Committee determines the Rule has been violated, sanctions will
be imposed accordingly
© 2016 CME Group. All rights reserved.
15
Q&A
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16
Thank You
© 2016 CME Group. All rights reserved.